A
recent cartoon shows the New York Stock exchange façade with bright yellow
“caution” tape in front of it.Caution
is indeed the watchword.

The
big news of the quarter just ended was the Fed’s action of cutting interest
rates by 50 basis points (one-half of one percent).This was a reversal of the Fed’s policy of the last couple of years,
and came in response to the sub-prime lending crisis (which has been the big
news of the last two quarters).Stocks
rallied sharply on the news, in what I would describe as a relief reaction, a
psychological kneejerk.It feels to me, at least for the moment, that we are seeing
the top in stocks.

That
the economy is slowing seems to be a given, and the Fed’s action of lowering
rates only serves to confirm that opinion.

Now here’s an
interesting thing:a couple of years ago, while the Fed was making all of those
consecutive quarter-point boosts to short term rates, the long term rates went down.Skip ahead to today:after
the Fed cut short term rates, long term rates have moved up.Perhaps you have to concede that the market is in control, and not the
Fed.At least the yield curve is
normalizing.

Stocks continue
to gyrate wildly.July, August and September saw the Dow hit levels of 14,000
(a record high), then slide under 13,000, and then rally back over 14,000.That last push was the reaction to the Fed, but two one-thousand-point
swings—around seven percent in each direction—in the course of two or three months do not make
for a settled stomach on the part of this writer.

I mentioned that
the Fed cut rates because the economy is slowing.We also have oil prices climbing to new highs, and the dollar going to
new lows.Government spending has
not slowed, and our Federal debt is poised to rise above 9 trillion dollars.

Given that demand
for housing has dramatically slowed, it is probably a non-issue that money for
mortgages has dried up. It remains to be seen if lower rates will ease
that situation.We are even
beginning to see cracks in the leveraged-buyout business.As the easy money disappears, deals fall through and buyer’s remorse is
a more common emotion at some buyout shops.Just desserts if you ask me.

So why are stocks
still at this level?I confess that
I don’t know.Perhaps it’s
because investors don’t want to put their money into real estate.Or perhaps they see that while corporate profit growth is slowing, it’s
still growing.Maybe, with interest
rates so low, there’s just no other place to put your money.Or maybe it’s all of that excess cash that I have talked
about previously.But overall, my
gut tells me that prices should be lower, for stocks and for bonds.

Bond redemptions
are accelerating as corporations rush to refinance at lower rates.My sense is that this is their last chance to do so, and that rates will
be higher, significantly so, within a couple of years.Bond investors will be well served by keeping maturities short and
quality high.

As for stock
investors, buying high quality companies at reasonable prices is always in
fashion.We will doubtless continue
to see dramatic swings in both directions, and I hope to be able to use
downdrafts as buying points.Volatility
notwithstanding, if we stick to a long-term philosophy I believe we will be
rewarded.